“Management doesn’t get paid to make shareholders comfortable.
-We get paid to make them rich”
Robert Goizeuta former Chairman & CEO Coca Cola Company
Here at the Science of Business Wealth we want to help you develop great answers to the following questions:
1. Are you making money?
2. Do you have enough cash to run your business?
3. Are you building long term wealth?
This post focuses on question 1. There are three levers to increase profit and we will examine each in turn to show you how to make more money.
Every business needs to be profitable.
It is easily determined by looking at your Income Statement or sometimes it is called the Profit & Loss Statement or P&L.
Sadly many business owners think they have a great business but in reality they have a Loss statement not a Profit statement!! (Ouch)
Here’s how your Income Statement works:
- Less Cost of Goods Sold
= Gross Profit
So let’s look at how we can improve Gross Profit. We have only 3 levers:
- Go get more clients and sell more to increase revenues
- Reduce your costs
- Raise prices which would increase your revenues
The key question is which strategy would be the most effective in improving your Gross Profit?
We surveyed 300 senior leaders and asked which strategy they thought would have the most impact from the following choices:
1. Increase revenues by 1%
2. Reduce Cost of Goods Sold by 1%
3. Raise prices by 1%
Our survey results said:
70% said they would sell more to raise their revenues
20% chose a reduction in COGS
10% chose to increase prices by 1%
Take a moment to make your pick and then we will reveal our answer.
We know the simple equation is:
Revenues - COGS = Gross Profit.
Let's take an imaginary company. It has revenues of $100, COGS of $60.
So Gross Profit is $40 (100-60=40).
The following graphic shows all 3 scenarios:
And voila! Raising prices is our winner! Perhaps some explanation:
1. Revenue Growth Strategy.
When we grow revenues those costs (COGS) associated with them also increase by 1%. Our Gross Profit increased by 40c. So for every revenue dollar increase we get a 1% improvement
2. Reduce COGS Strategy
Here revenues stay the same and COGS comes down giving a net increase in Gross Profit of 60c or 1.5%
3. Raise Prices Strategy
If we raise prices then our revenues must increase by the same percentage. However, our COGS remains the same (input costs did not increase as we just raised price) giving us a whopping $1 or 2.5% improvement. Interestingly, this strategy was only picked by 10% of our respondents!
OK we know it is not straightforward to just raise prices. However the opposite is don't be so quick to discount prices to win new orders as it has a disproportionate effect on the business ability to make money.
Quick tips to improve your Profitability
1. Make sure your look at your Income Statement (get one from your bookkeeper—you should be looking at this weekly or monthly)
2. Look at your pricing and how you articulate value—most small business owners undercharge for the value they are delivering
3. Analyze your customer and product portfolio. It is common to find that only 30% of the products and service you sell are profitable!!!! So you can prune or re-price the ones that are not.
4. Remember you don’t have to get more clients in order to make more money!
Hope you enjoyed this tip.
Until then, goodbye from Mick & Andre